Picking Our Environmental Battles: Removal of Harmful Subsidies or Carbon Taxation?

Abstract

In this paper, we compare the effects of removing harmful fossil fuel subsidies with the replacement of the energy taxation by a carbon tax in Portugal. Since energy taxes focus on the energy content of the different energy products eliminating these provisions only brings their prices in line with their energy content. On the other hand, replacing the energy tax system with a tax on the emissions content of the energy products aligns the fossil fuel prices with their emissions content. We show that while replacing the energy with a carbon tax is a policy of a magnitude about eight times as large as the removal of the harmful subsidies, the effects of emissions are twenty times larger and the adverse economic and distributional effects only about twice as large. Accordingly, replacing the energy tax with a carbon tax is a much more cost-effective way of reducing emissions. This may suggest that focusing on the removal of harmful fossil fuel subsidies may be an environmental red herring.